Should businesses utilize debt or equity financing to raise capital for growth
By Donald Williams Williams Accounting & Consulting
Building and growing a successful business is never easy. You may need an infusion of outside capital to start or expand your operations. There are two main ways that businesses raise money: Debt financing and Equity financing.
There are advantages and disadvantages to each option. Which one is better for a business depends on many different factors. Here’s a brief guide to financing.
What is Debt Financing?
A company can raise money by taking on debt, which is called Debt financing which involves raising capital through selling debt instruments. In effect, the business is taking out a loan. Though, the structure of the loan can vary significantly depending on the specific circumstances. Debt financing might be the right option for your business if you are looking to raise money.
Here are three potential benefits of debt financing:
- Retain Full Ownership: When you finance through debt, you will not lose any of your ownership stake in the business.
- Predictable Repayment Terms: Repayment terms are generally negotiated when a debt financing agreement is entered. This makes the terms quite predictable—you will be able to know exactly what you are getting into.
- Tax Deductible Interest Payments: Debt carries interest. While this is a downside, the interest payments made by a business are generally tax deductible.
What is Equity Financing?
Equity financing is the primary alternative to debt financing, and consists of the process of raising capital through the sale of shares. A business owner sells off some of their ownership interest in the company for money right now. It may be the right choice for your business.
Here are two potential benefits of equity financing:
- No Repayment: When you raise money through equity financing, you generally do not need to repay anything.
- Your Debt-to-Equity Ratio Remains Constant: As equity financing does not involve the taking on of debt, a company’s debt-to-equity ratio remains the same—meaning it may be easier to get financing in the future.
How to Decide Between Debt Financing and Equity Financing
Raising money to build or grow a business is complicated. It is crucial that you understand the advantages and disadvantages of all available options. A business consultant can sit down with you, review your company’s specific financial circumstances, discuss your long-term goals, and help you carefully weigh the pros and cons of debt financing versus equity financing. With deep experience helping entrepreneurs start-up and scale-up successful companies, the business team at Williams Accounting & Consulting is standing by, ready to help you determine the best course of action.